- Ichor is rapidly seeing operating momentum come to an end due to the COVID-19 outbreak.
- The outbreak caused a big sell-off and despite a 50% recovery from the lows, shares are down 40% from the highs.
- Appeal is increasing, yet the near-term outlook remains dismal.
- Holding 50% of my target position, I feel no urge to buy in the low-$20s, although a re-test of levels in the mid-teens might prompt me to double up on the position again.
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Late January I looked at Ichor Holdings (NASDAQ:ICHR) as I concluded that momentum has returned. I concluded that the company was delivering on impressive sequential growth as the underlying results fueled momentum in the share price, which made that I was happy to take some profits after shares nearly doubled in the 18 months. Ever since we have been in for a true shock as shares lost nearly half their value in response to the COVID-19 outbreak.
The Moves, A Roller Coaster
Having gone public at just $9 per share late 2016, Ichor was almost an instant success with shares tripling to levels in their $30s in 2017 as the cyclicality of the business caused shares to end 2018 around the $15-mark.
The cyclicality is the direct result of the activities of Ichor as it is a provider of subsystems, used in the process of manufacturing semiconductor chips, as in fact this is quite a specialized task. This specific activity and desire to remain lean make that many semiconductor manufacturers have outsourced this task. Given this and the fact that this is a cyclical industry, companies like Ichor come to fill in the blanks.
In the year 2016, the year in which the company went public, Ichor generated $406 million in sales on which it reported operating margins of 6%. For the year thereafter, revenues grew to $656 million as margins improved to 7%, as growth was in part driven by two acquisitions which came at a price tag of around $180 million. The company reported earnings of $2 per share in 2017 on a GAAP basis, with adjusted earnings about half a dollar higher.
In the second half of 2018, the floor was falling under the sales of Ichor with the company seeing one of its painful cyclical downturns as revenues fell to an annualized rate of about $500 million a year, and that is despite some incremental acquisitions being made. The debt incurred and the fact that earnings were depressed pushed shares to just $15 by the end of 2018.
During 2019, some optimism kicked in as in November 2019 third-quarter sales recovered to $154 million, with the company guiding for fourth-quarter fiscal year 2019 sales of $180-190 million, causing shares to recover to levels in their $30s. At the start of 2020, the company reported fourth-quarter revenues of $189 million and even better, the first-quarter outlook for 2020 called for sales of $210-230 million, up $31 million at the midpoint of the guidance. I figured this anticipated increase in sales could push earnings up to a number of around $3 per share.
This was all positive as the rapid cash flow generation makes that debt will come down and I furthermore liked the fact that ASML (ASML) was added as a large third customer, reducing the reliance risks on its two major customers.
With the very strong outlook for 2020 causing a jump from $31 to $40 overnight in January, I noted that a 13 times earnings multiple looks cheap, but this is a cyclical business with this lesson only having been learned a year ago. In January, I observed that shares essentially rose 150% from the lows little over a year ago. All of this made that after having cut half my position, I continued to hold a free ride on the remaining 50% of my position and with the benefit of hindsight this has been a painful decision to not cut the entire position, of course.
What followed was of course the COVID-19 crisis, causing shares to hit just $15 by mid-March before rebounding to $26 and now trading at $22, still saddling investors with losses of around 45% from January’s peak.
The first-quarter results came in as planned and guided with sales totaling $220 million. Based on adjusted accounting, the company reported operating margins just above 7% and adjusted earnings of $12.1 million, equal to $0.52 per share. GAAP earnings only came in at $0.15 per share. At least we have to adjust for $2.9 million in stock-based compensation, or about $0.10 per share, for a more realistic earnings just above $0.40 per share, running at an annualized number of $1.60-1.70 per share.
This is disappointing as it is more or less in line with the fourth-quarter numbers, even as first-quarter sales growth has been rather strong compared to the fourth quarter. The company claimed that disruptions related to COVID-19 impacted margins by about a percent indeed.
The company ended the quarter with $42 million in cash and $181 million in debt, for a net debt load of around $140 million as further deleveraging would be comforting as we are dealing with uncertain times. Of course, the peak has already been observed, yet the second-quarter outlook could have been worse with sales seen at $180-220 million and adjusted earnings seen between $0.32-0.54 per share.
While shares have seen a 60% pullback between January and March, the company has not lived up to expectations as well. The annualised earnings power of $2 per share in 2019 was expected to go towards $3 in my estimate, but despite the great sequential increase in sales between the fourth quarter of 2019 and the first quarter of 2020, the company has not reported higher earnings, just a four-cent improvement on an adjusted basis, although this is largely attributable to COVID-19 related disruptions.
Hence, based on my expectations, earnings multiples have only fallen from about 13 times to 9 times at the low, split pretty equally between declining earnings expectations and multiple compression. Based on earnings power of around $1.70 per share, if I adjusted for stock-based compensation, earnings multiples come in at 13 times, although earnings come in at a lower level of course. With more earnings pressure seen in the coming quarter/quarters I am not dipping the toes into the water here.
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This article was written by
Analyst’s Disclosure: I am/we are long ICHR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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